Measuring risk for businesses

Updated on August 22, 2014

Measuring Risk

Risk is a very influential factor in many business decisions. Managers must know how to control and minimize risk to protect their companies from loss. The first step in controlling and minimizing risk is to measure risk and the potential outcomes. The company must be aware of the risks involved in their decision making and the potential outcomes from various decisions. Many risk measuring techniques are available for the managers to use in their risk assessments of companies and projects. The two main categories of risk measuring techniques are qualitative methods and quantitative methods. Qualitative methods compare the significant risks and the effects they will have on a projects outcome. Quantitative methods attempt to find absolute value ranges with probability distributions for a business or project outcome. Three techniques will be identified and the use and application will be described in this article. The techniques are Delphi and risk matrix charts, which are qualitative techniques and decision trees that is a quantitative method.

Delphi Technique

The Delphi technique is used to obtain a prediction or a forecast of future events or outcomes. The technique uses information gathered from experts independent of each other to form a consensus at the end. A chairperson will be in contact with each expert independently, and they will summarize all the expert’s collective opinions. The chairperson will then take the summary back to each expert to see if they will revise their opinion based on the collective findings. The chairperson will continue the process until a consensus is reached or they believe that no benefit will come from further rounds. This technique is more efficient than a group because it eliminates many of the negative pressures that exist in groups. In a group setting the experts may be influenced by pressures from the other group members and their opinions. The benefits of the Delphi techniques also avoid pressures of conformity, personal characteristics, and compatibility. This technique will give managers an expert opinion of a future event or outcome through a consensus of independent opinions.

Risk Matrix Charts

Risk matrix charts are a qualitative method used to separate high-impact risks from low-impact risks. This method allows the company to ensure the high-impact risks are maintained and controlled before the low-impact risks. The technique determines the impact and the probability of the effects of the risk on the business. The charts will identify the risks that will cause the business the most harm and allow managers to focus on mitigating these risks. The matrix includes for categories; puppies, kittens, tigers, and alligators. The puppy’s category includes events that have a high probability and a low impact to the business. The kitten’s category includes events that have a low probability and low impact on the business. The tiger’s category includes events that have a high probability and high impact on the business and the alligator’s category includes events that have a low probability and high impact on the business. The technique allows the managers to rank risk in class according to impact and probability. The managers will want to focus on the tiger’s category first then the alligators second. The risks that can have the greatest impact and probability on the company will need to be addressed before the other risks and this technique will rank the events in order for the managers.

Decision Trees

Decision trees are a quantitative technique that managers with multiple options can use to choose the best option for the company. Many managers are faced with many options and only have the resources to choose one of the options. Decision trees are like a flowchart of possible occurrences of events after a decision is made. A decision is made then the other possibilities of events that may occur are depicted graphically. A line or a branch is drawn from the decision made to all the possible events or outcomes that may develop because of the decision. This continues until the possible outcomes or chance events are discovered because of each decision. The technique will give the decision maker an idea of what all the possible outcomes will be after a specific decision is made. This method will evaluate all the possible outcomes of each option and inform the manager of extra cost that may be included in each decision. The manager can use the information for strategic planning and develop alternative plans for each possible occurrence if the option is chosen. The options with the most possible occurrences will depict those with the most risk. This method is like a blueprint for strategic planning by listing all the possible occurrences and chance events that may transpire because of the choices made and prepare the manager to address each event in case they materialize.

Measuring risk is a key aspect to risk management. Many techniques exist and the managers must choose those that are the most practical for each investment type. The two main categories of risk measuring techniques are qualitative methods and quantitative methods. Two examples of the qualitative methods are the Delphi technique that uses a group of independent expert opinions to form a consensus to forecast a future event and the risk matrix charts that identify the impact and probability of occurrence an event will have on the business and ranks them in the order of importance. A quantitative example is the decision trees that develops a graphical view of possible occurrences or chance events that may develop after a specific decision is made. Each method measures risk differently and the manager must choose the technique that will be the most applicable to the specific situation he or she is trying to measure.

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